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State Bank… But why though?

10 Jul 2017

After all the “nationalise the South African Reserve Bank” chatter last week, there have been renewed calls for the South African government to establish a state bank. As the ANC attempts to pivot its way into every populist EFF policy, including the establishment of a state-owned bank, the EFF is probably the best litmus test of where government policy is going.

“We want a state-owned bank that is competitive. There must be a huge difference forcing you [private banks] to come down and meet the competition of the state.”

The State Bank premise

While there’s lots of rhetoric out there about this, I struggled to find any think-pieces. You know – something that actually explained why a ‘state bank’ is needed and how it would work. In the end, I found this article on ‘alternative economic and business news’ website, UJUH. The article identifies four reasons for a state bank:

The banking sector needs more competition. A quote: “The oligopoly that exists today has created a dominance by few private banks that is not benefiting neither the country nor the public. For example, banks are sometimes unnecessarily risk averse and at times activities that are viable are simply not supported because currently they can pick and choose. So banks have moved down the risk curve and yet price for high risk. Competition will improve intermediation.”

Current banking services are insufficient for the unbanked, because retail banks have a profit-making motive. A quote: “State banks will not be driven by a focus on only Profits or Return on Equity and therefore will have a higher appetite to bank poor people in townships and rural areas.”

Private banks do not adequately support small and medium-sized businesses. A quote: “Private Banks have made a small contribution to the development of SMMEs relative to the capital they hold. They deem SMMEs to be too risky. Private Banks are quite happy to source cheap deposits from townships and rural areas but scant bear a thought as to how they can sustain and invest in those communities which ultimately will also benefit them.”

Currently, the State only takes on bad risk during banking crises, while allowing others to take on the good risk in good times. A quote: “A state bank by competing for good government business will be able to create a “subsidy” or headroom for government to focus on the unprofitable business. That is, if fees and interest paid to the state bank by the public sector and private sector customers is managed wisely, it would create a more sustainable fiscal environment by reducing the demand on the public purse.”

So, to be completely honest, I’d strongly agree with points 2 and 3. By all accounts, it is not profitable for large retail banks to service the unbanked. It is also not profitable for large retail banks to service SMEs*.*To clarify, I think that these are the only two relevant arguments. The point about the sector needing more competition is a weird combination of socialist and free market thinking. Even if the sector needs more competition, history doesn’t support the notion that a parastatal will somehow deliver it. And as for the last part. I mean, it directly contradicts the ‘non-profit’ motive of a state bank. If the bank is meant to make no profit, then where is this ‘subsidy’ going to come from?

But the bigger question is: why?

The State Bank hurdles

Here is the awkward reality (and it’s one that I’ve been on about for years): South Africa bats far above its league in terms of financial regulation and oversight.

There are consequences to having Basel III as part of our banking regulations. There are consequences to having established a Financial Intelligence Centre and Money Laundering Council in 2001, as a response to 9/11, in order to combat money laundering and the financing of terrorism-related activities. We have adopted the first world standards of financial supervision and oversight.

Some of the practical realities:

The strict capital requirements of Basel III limit the amount of risk that banks can take on; and

Increasingly onerous FICA requirements have drastically increased the amount of compliance work that needs to be undertaken for every type of banking product.

Yes, there may be a history of collusion between the four big banks. But these are more recent developments. I mean, South Africa only began to integrate Basel III into the banking rules in 2015.

The consequences:

The appetite for risk-taking has decreased (which means both less financing for the riskier segments of the population [the unbanked and SMEs], and costlier interest rates where that financing is available); and

Higher compliance costs, which translate into higher bank charges.

No ‘State Bank’ is going to be exempt from this.

Those are just modern banking realities.

Or it could self-exempt like SAA does

This is the more nightmare-ish example. If the obstacles are capital requirements and compliance:

The State could decide to continually re-capitalise the bank with taxpayer money, effectively removing any concern about risk-taking #socialistbanking. For the record, this would be like the State electing to take on the bad risk from banking crises in advance. All the bad borrowing would conveniently locate itself in the path of the government coffers from the outset. And the collapse of the bank, with its loan write-offs and government-sponsored refunds to depositors, would basically be a form of social grant.

The State could also decide to by-pass compliance by capturing the SARB (the current enforcer of banking oversight), and giving itself free passes on the FICA front.

If either of those things happened, we could see the private banks undergo severe stress. Because borrowing cheaply from a state-funded institution with little-to-no-compliance-requirements? It might be short-term, but it’s well attractive.

And all this leaves out the other macro-monetary problem, of course. Which is that the primary money creator is not the central bank. Instead, it is the network of retail banks, who accept deposits and then make loans using fractional banking.

So a state bank that is engaging is some reckless, low-cost credit would be a de facto money-printing agent. With all the potential inflation that comes with it. As well as an even greater incentive to ‘capture’ the SARB, who would otherwise control that.

Conclusion

The basic conclusion: if the State Bank plans to operate within the confines of the law, then it probably won’t be that much better than any of the current banks. Because the current problem seems to be over-zealous banking regulation rather than a ‘profit-seeking motive’.

And if the State Bank somehow exempts itself from the over-zealous banking regulations, then that process might well end up completely self-defeating in the long-term.